Hot Off the Web- March 1, 2010

Personal Finance and investments

Brett Arends in WSJ’s “Buffett’s advice for the rest of us”summarizes some of the key elements of Buffett’s advice: (1) stay liquid (always have more than enough cash to meet expected requirements), (2) buy when everyone is selling, (3) ”don’t buy when everyone is buying”, (4) “value, value, value”, (5) “don’t get suckered by big growth stories” (especially when you can’t evaluate them), (6) “understand what you own” and (7) “defence beats offense”

In the WSJ’s “The hidden cost of mutual funds” discusses how a fund’s expense ratio (an average of 1.31% of U.S. mutual funds, and perhaps almost double that for Canadian ones) might be just the tip of the iceberg of the annual costs incurred by an investor in a fund, “other costs, not reported in the expense ratio, related to the buying and selling of securities in the portfolio, and those expenses can make a fund two or three times as costly as advertised.” Other invisible cost area is trading costs (0.14-2.96%, average of 1.44% in one study), components of trading costs include: brokerage commission, bid-ask spread, opportunity costs and market impact costs. The “turnover” rate is a good indicator of the total costs (a 100% is high); fund size (small is lower) and style (aggressive growth is higher) also affect overall cost of ownership.

Jason Zweig is the bearer of bad news in WSJ’s “Brokers win, Investors lose key reform” where he reports that 1000+ page U.S. financial reform bill winding its way through the Senate looks like it will emerge without “a key provision requiring stockbrokers, insurance agents and others to act solely in the interests of their clients”, i.e. without the much anticipated requirement for fiduciary responsibility. “If you get charged for transactions when what you really want is guidance, the result can be too many trades and not enough hand-holding. Under the fiduciary standard, you would pay primarily to get advice rather than to trade. If the competition for advice increases, then its quality should also go up, helping to clarify how valuable a broker’s services actually are (or aren’t).”

You might find it interesting to peruse John Heinzl’s 39 steps to becoming a successful investor in the Globe and Mail’s “Thirty-nine investing secrets revealed at last”.

From Ken Kivenko’s Fund Observer “Email from a reader: I just got a letter from a fund Company advising me that my Segregated fund was near the end of the 10-year guarantee period. The fund hasn’t made a cent. The letter said that if I didn’t inform them that I wanted to end the policy by a certain date they would automatically initiate a policy for another 10 years. I said DROP DEAD and took the cash. Please warn all your readers. Apparently maturity date doesn’t mean maturity date. – Anonymous 86 year old widower, Calgary AB”. (Pay attention if you still own structured products with guarantees and maturities and/or segregated funds (insurance company mutual funds). As an aside, you might not want to buy this insurance company’s product, but you might want to own their stock; they got investor’s money for ten years and returned it to them at the end. Over those ten years $1 invested in 5% 5-year GICs could have become $1.63!)

Pensions

As indicated in my last week’s blog on the proposed settlement agreement “Nortel Settlement Agreement: What’s in it for pensioners?”, the potential rights (to priority and to sue those responsible for the pension underfunding) of Nortel’s Canadian pensioners are in the process of being crushed as a result of this agreement, all in exchange for about $2,000 value. The good news that emerged over the weekend is that U.S. and Canadian courts have rejected U.K. pension regulator’s attempt to add an additional $3.2B to the claims against the Canadian estate as reported in “Nortel avoids U.K. pension battle”.

In the Montreal Gazette’s “It’s time to take action on company pensions” Jay Bryan challenges Canadian Finance Minister Flaherty to address in this week’s budget “the rising apprehension of Canadians about their retirement security…Right now, there’s simply no Canadian safety net for troubled company pension plans. If a company goes into bankruptcy at the same time as its pension plan has a shortfall – which is exactly when this is likely to happen – too bad for pensioners.”

The Economist’s “Time spent in retirement has sharply increased” reports that “Official retirement ages have failed to keep pace with rising life expectancy, making pensions increasingly unaffordable.” The article has an interesting graph showing “official retirement ages” and change in the number of “years in retirement” over the last 40 years in 17 OECD countries. Incremental time in retirement show is as much as 15 year extra years compared to 40 years ago.

Real Estate

The latest Teranet- National Bank House Price Index reflecting December 2009 prices shows that Canada’s residential real estate market is still firing on all cylinders. December figures of the six city index are up YoY 5.6%. “December’s robust 1.2% monthly gain pushed the composite index above the pre-recession peak, that is, to a new record”!!! Toronto, Calgary, Vancouver and Montreal were each up more than 1% in the month of December.

In (a potential lesson for Canadians) the Financial Times’ “How long has the lucky country got?” Edward Chancellor looks at Australia’s still strong real estate market. Between 19996 and 2006 both U.S. and Australian real estate prices increased 90% in real terms. Since 2006, U.S. home prices dropped 30% and Australia’s increased by 30%. Reasons given for the difference includes: less over-building, less “liar loans” and “subprime detritus”, mostly floating rate mortgages (which are generally lower- so far), and Australia’s stimulus dollars went to consumers instead of the banks. “Aussie house prices have not fallen since the early 1950s. A certain complacency is therefore understandable. Yet not long ago many Americans also believed that domestic home prices could never fall.” (Well, at least Canadians remember house price drops of about two decades ago, so we should be less complacent.)

The Florida real estate story is still not great to say the least. The Sun Sentinel’s “Bump in one county’s home prices raises hope that market is stabilizing” (the title does not quite reflect the data in the article) and the Palm Beach Post’s title for the same story is “’Devastating’ in the short term: Sales of existing homes drop unexpectedly drop”indicate 28% drop in existing home sales in January as compared to December, with Palm Beach County sales down 36%. January YoY sales are up slightly, but then January 2009 was in the middle of the Great Recession.

In the Herald Tribune’s “A look at the housing market that may induce some chills”Tom Bayles looks at a new report from the Urban Land Institute in Washington which predicts a “wholesale change in many sectors of American life” due to the housing crisis. Among the predictions are: another 10% drop in house prices by 2011, 40% of all homes underwater, “the age of suburbanization and growing home ownership is over”, and metropolitan area will urbanize but Florida will e one of the slowest to do so. Florida “has moved from being the state with the most net domestic migration from July 2001 to July 2005 down to 45th with a loss of 37,179 people to other states from July 2008 to July 2009.”

Steve Ladurantaye in the Globe and Mail’s “U.S. slump in sales of new homes threatens recovery” discusses the impact of U.S. new home sales having fallen to a 47 year low in January, on the overall U.S. economy.

Things to Ponder

In the Financial Times’ “Sacrificed to the winds of change” Pauline Skypala discusses how “changes afoot that some see as damaging from the perspective of corporate governance, such as the rise of exchange traded funds. Being passive vehicles, there is little incentive for the managers to engage with the companies they hold”. (I.e. there will be less oversight on the practices of the already lax and often self-serving corporate management.)

In the BusinessWeek’s “Debt: The big bang has just begun” Frank Aquila writes that “While asset values can evaporate in an instant, the indebtedness assumed to acquire the asset does not. Significant debt can take years and even decades to eradicate; unless, of course, the debtor goes bankrupt.” Aquila reports that $1T (not billion) of junk bonds are due by 2015. Refinancing these bonds will be impeded by competing with “federal, state, and local governments and international sovereign debtors will all be borrowing ever-increasing sums.”

The Barron’s Thomas Donlan writes in “When Greece met Goldman” that “if you lie down with dogs, you’ll get up with fleas”. About a decade ago, Greece (“spending enthusiastically and taxing ineffectually”) in order to meet the entry requirements into the EU had to “dress up its finances”. Goldman Sachs, “a firm that lives to help its customers do what they want, even if it isn’t in the clients’ best interests”, helped Greece borrow in Euros with currency hedged without having those hedges show up as the country’s liabilities. “All sides ignored the fact that the currency hedges were structured to lose money for Greece in proportion to the debt being hidden, plus something left over for Goldman — like about $300 million.” The lesson to all “After decades of developing ever-more efficient ways of front-running their customers, Wall Street casino sharks have ceased to care about their clients. The sharks have no concept of fiduciary duty, unless there is a controlling legal principle and cops to enforce it.”

In the Financial Times’ “Time to outlaw naked credit default swaps”Wolfgang Munchau argues that trading CDSs without ownership of the underlying bonds should not be permitted. “Economically, CDSs are insurance for the simple reason that they insure the buyer against the default of an underlying security. A universally accepted aspect of insurance regulation is that you can only insure what you actually own. Insurance is not meant as a gamble, but an instrument to allow the buyer to reduce incalculable risks. Not even the most libertarian extremist would accept that you could take out insurance on your neighbour’s house or the life of your boss.” “Naked CDSs have played an important and direct role in destabilizing the financial system. They still do. And banks, whose shareholders and employees have benefited from public rescue programs, are now using CDSs to speculate against governments.”

“No real sign of structural reform” John Dizard asks “why so little has been done to fix the securitization structures and markets since the onset of the crisis. The banking system does not have the direct lending capacity to replace what the securitization markets could provide two years ago. The capital and people to do it aren’t there. So the calls across the political spectrum for the banks to resume lending are just empty talk. Deflationary credit contraction looms.” Unfortunately his answer is that “incredibly, the sell side is still in control of the debate. Complex, opaque securities structures, written in imprecise language, have been good to the securities dealers over the years. As they know in the lizard lobe of their collective brain, full disclosure and efficient markets would lead to thin margins and paltry bonuses. If the securitization markets are to be revived, the real money investors on the buy side have to organize themselves and dictate the terms of reform. That’s not happening – yet.”

And finally in an interview with the FPA Journal entitled “Zvi Bodie on financial planners and ‘First, do no harm’”  Professor Bodie expresses some strong views on the practiced of financial planners/advisors. “It seems that our idea of financial literacy is to transfer risk from the corporate sector—the investment industry and financial professionals—to the consumer. It’s a type of fraud.” On TIPS and ”safety-first” he says that “if you want to build a safety net for a client’s retirement you need default-free securities of every maturity that are linked to the cost of living“ and he personally practices what he preaches with 100% of his retirement portfolio in TIPS. On “misleading” target-date funds he says “I took a look at how target-date funds performed recently and those with a target date of 2010 lost more than 30 percent of their value, on average. Is that appropriate for people close to retirement?” On the differences between his views on equities and those of Jeremy Siegel, he comments that “Jeremy emphasizes the positive risk premium of equities and I’m focused on the risks of equities. My opposition, if you will, is not Jeremy. It’s the entire investment industry that tries to persuade investors that the risks of equities are lessened in the long run. “To focus on the probability of success and leave out of the discussion on the risk and severity of failure is unconscionable.” On financial planners, he says that they need a new business model to replace the percent of AUM (assets under management), once their customers will start using the Bodie model of investing. His message is that you should steer clear of anyone in the investment industry who frames success in terms of probability of success. (It’s a great read; it challenges a lot of what is the basis of current financial planning practice.)